A Beginner’s Guide to Cryptocurrency
Although crypto-mania has only recently begun to take hold, the origin of these digital currencies goes back much farther than most people realize.
June 21, 2021
These days, it’s hard to avoid cryptocurrency. After the price of a single Bitcoin hit an all-time high of $63,000+ in April 2021, the cryptocurrency space has become something of a modern gold rush — it seems like everyone’s trying to get their hands on a big nugget of the next Yukon gold.
Although crypto-mania has only recently begun to take hold, the origin of these digital currencies goes back much farther than most people realize. The first theoretical cryptocurrency — ecash — was conceived in 1983 by the American cryptographer David Chaum. Later, the NSA began investigating how cryptocurrencies could work. In 1998, computer scientist Wei Dai expanded on these ideas to describe an anonymous and distributed cash system that he called “b-money.”
However, it wasn’t until 2009 that these precursor ideas took shape in the form of Bitcoin. Created by Satoshi Nakamoto, whose true identity (or possibly identities) is still unknown, Bitcoin has grown from an underground currency (primarily used for illicit purposes) to a major player in the global financial sphere.
This introduction to Bitcoin and cryptocurrency will provide a basic overview and cover how cryptocurrency works for beginners.
How Does Cryptocurrency Work?
If you opened up a book called “What Is a Cryptocurrency for Dummies?” one of the first topics it would cover would be cryptocurrency ownership.
Answering this question isn’t as easy as most people would like. On the surface, you own cryptocurrency the same way you own anything else. For example, when you buy one Bitcoin, you own a Bitcoin coin, in the same way, that when you have a dollar, you own U.S. currency. Just like every dollar bill has a serial number, your Bitcoin coin has some unique numbers attached to it that identify it.
However, things get a bit more complicated when you throw in the fact that Bitcoins don’t exist in the material world. So, when you own a Bitcoin coin, although you own the coin in practice, you don’t actually have a physical copy of that coin. Instead, the transaction is stored in the blockchain ledger, and you retain what’s called a private key that allows you to spend the currency.
In short, cryptocurrencies use blockchain ledgers and implement complex cryptography to create a decentralized currency.
Let’s break that down into plain English. Cryptocurrencies “run” on something called a blockchain. You can think of a blockchain as a special type of database that uses complex cryptographic functions to save data in groups (blocks) and link (chain) those groups together — hence the term “blockchain.”
Cryptocurrency is considered decentralized because the database isn’t run by a single person or group of people. Instead, it is run by everyone that owns the currency. Essentially, everyone that buys crypto gets a copy of all the data on the blockchain. This contains a list of all the transactions that have ever occurred for that currency, which is referred to as the “ledger.”
When you buy cryptocurrency, you don’t own a physical or even a digital coin. Instead, the ledger simply notes that an amount of the currency has been sent to a user.
Cryptocurrencies are secure precisely because of this distributed ledger, which maintains a record of who has how much of the currency. If someone were to try to change a copy of the ledger to give themselves more currency than they really have, the ledger would check itself against the other copies and quickly note a discrepancy.
This means that to conduct a fraudulent transaction or falsely give yourself more cryptocurrency, you’d have to change every single copy of the ledger, which is practically impossible.
If that all sounds too complex, you need to know this: when you own a cryptocurrency coin or token, what you own is a private key, which allows you to “unlock” a certain amount of that cryptocurrency and do with it what you own you will.
How Do You Buy Cryptocurrency?
Thanks to the huge increase in the popularity of crypto, buying coins has become easier than ever.
You can buy crypto from various brokers, but perhaps one of the most popular ways is via Coinbase, largely because it’s very easy to use and fully regulated. To buy cryptocurrency from Coinbase or other popular platforms, all you need to do is sign up, deposit some money in USD, and make a purchase. The service will provide you with an online wallet where you can send and receive coins.
However, not every broker works in the same way. Robinhood, another popular broker that allows the buying and selling of crypto, does not allow you to send your currency to another wallet. Essentially, this means that you can’t actually use the crypto you bought to make purchases.
Because of the huge diversity of brokers out there, it’s important to look carefully at each of their individual policies to determine which is best suited to your individual needs.
How is Cryptocurrency Different from Other Investments?
No cryptocurrency introduction would be complete without a discussion on how cryptocurrency differs from other investments.
One of the first things that any potential crypto investor should know is that cryptocurrency is a much newer asset class than other common investment vehicles, like stocks and bonds. That means that we know a lot less about it, including how it performs and what affects its price. While stocks have been bought and sold since at least 1602, cryptocurrencies have only been around since 2009.
As a result, cryptocurrency is generally viewed as a riskier investment than stocks, bonds and other more traditional assets. With that risk, there’s a lot more volatility, which is why some cryptocurrencies have shot up in value so quickly. It’s something of a feast or famine situation: crypto can make some people millionaires in moments, but an unpredictable drop in value can wipe out their life savings just as fast.
The fact that cryptocurrencies don’t have any physical property that they correspond to makes them harder to understand for many, driving increased volatility. For example, in a real estate investment, the value of the transaction is at least partially attached to the physical house itself. With crypto, however, it’s just numbers flitting across a computer screen — along with the emotions of millions of investors — that determine its value.
In some ways, cryptocurrency trading and investing can be best compared to foreign exchange trading and investing, in which traders buy and sell currencies from different countries. However, these currencies still have the backing of major nations’ economies, while cryptocurrencies do not.
What are the Different Types of Cryptocurrencies?
Generally speaking, cryptocurrencies can be divided into three types:
Bitcoin: This may sound surprising, but Bitcoin is in a class of its own in some ways. Often recognized as the first cryptocurrency, it is one of the least mysterious of all crypto investments.
Altcoins: Altcoins often have no functional difference compared to Bitcoin. Instead, they’re considered altcoins (short for alternative coins) simply because they’re an alternative to Bitcoin. Examples of altcoins include Ethereum, Bitcoin Cash, Litecoin, and Dogecoin. However, not all altcoins are created equal: some have a much better track record than others, and new varieties launch almost daily.
Tokens: Tokens are cryptocurrencies that don’t exist on their own native blockchains. This is a bit of a technical concept, but it essentially means that these currencies “run” on another currency’s “software.” One example is Zilliqa, which runs on the Ethereum blockchain.
Some of the currencies that people are currently paying a lot of attention to include (in no particular order):
Is Cryptocurrency Safe?
This is the million-dollar question — literally, in some cases. If you’re asking the question “what is cryptocurrency for beginners,” your next query is likely to be whether or not cryptocurrency is safe. The answer, however, depends entirely on your definition of “safe.”
Cryptocurrencies are, without a doubt, much more volatile than many other investments, which means there is more risk involved. There are also quite a few scams out there, so investors should be careful.
However, despite the high volatility and the numerous scams, there’s nothing inherently dangerous, sleazy or nefarious about cryptocurrency itself. Many reputable companies are involved in the crypto space, so the answer to this question comes down almost entirely to your risk tolerance.
How Cryptocurrency Works for Beginners: The Bottom Line
Cryptocurrency is a fascinating development in the financial sector, but the introduction into cryptocurrency isn’t as simple or straightforward as logging into your brokerage account and purchasing index fund shares.
Further, despite all the media hype you may be seeing, buying cryptocurrency isn’t usually a one-stop ticket to financial success. Suppose you have extra money you can afford to lose. In that case, an introduction to Bitcoin and cryptocurrency may be worth exploring — but it can’t take the place of more foundational financial behaviors, such as opening a savings account, building a diversified portfolio and paying off your credit card debt.
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